Should I Buy British American Tobacco for My ISA?

LONDON -- I've long been a fan of Individual Savings Accounts (ISAs) as tax-efficient wrappers for equity holdings. Quite simply, if you're going to buy and sell shares -- especially as a long-term investor -- then it makes sense to do it inside an ISA.

There's no further income tax to pay on dividends, no capital gains tax to pay at all, and total freedom from the burden of reporting both income and capital gains to the taxman. Want to know more? Start here.

And simply put, from both the capital gains and income perspectives, I reckon that British American Tobacco makes an ideal ISA share. Why? Let's take a look.

Decent yieldTrading today on a forecast yield of 4.7%, an investor making full use of his or her 11,280 pound annual ISA allowance for 2012-2013 to buy British American Tobacco could earn 530 pounds in dividends next year -- without having to pay a penny more in income tax. Which is especially useful if you're a higher-rate taxpayer, of course.

Better still, British American Tobacco is a cash cow with a long-term track record of throwing off juicy dividends -- and juicy dividend growth -- year after year. Which is why, of course, it's long been a share that's popular with income investors.

What's more, British American Tobacco is also a strongly defensive share, and a business whose customers -- quite literally -- are addicted to its products. So investors can be reasonably assured that the dividend growth that the share has delivered in the past can continue into the future.

And just look at what that growth has delivered. Back in 2008 -- the start of the worst recession for 60 years, you'll remember -- British American Tobacco investors were rewarded with an annual dividend of 83.7 pence per share. For 2012, the company announced investors would receive 134.9 pence per share.

Over the 2008-2012 period , that's an annual growth rate of 12.7% -- not bad for a recession, and a business long since supposed to have gone ex-growth.

Capital upsideBut if British American Tobacco's income performance is fairly compelling, its track record from a capital growth perspective is pretty decent, too. Over the last 10 years, the growth in British American Tobacco's share price has outstripped the FTSE 100 index by a factor of five.

Put another way, back in 2000 you could have picked up British American Tobacco shares for around 4 pounds. Today, they're changing hands at over 34 pounds.

That's right: This solid, unassuming cash cow turns out to have some pretty nifty legs. The result? Just the sort of capital gains that a savvy investor will want to shield from the taxman's clutches.

Decent prospectsBut will those gains continue? Has British American Tobacco's share price run out of steam? I don't think so.

To be sure, tobacco continues to attract adverse headlines, smoking restrictions, and advertising restrictions. But people still continue to smoke the stuff, and demand shows no sign of entering a terminal tailspin.

All of which -- plus the generous dividend -- can be had on an undemanding forecast price-to-earnings (P/E) ratio of just 14. Tempted? I certainly am.

Good companyNor am I alone in appreciating British American Tobacco's sterling qualities. Investing legend Neil Woodford, it turns out, is also a fan -- of both British American Tobacco and the tobacco sector in general.

And with 21 billion pounds under management, coupled with a track record of comfortably outstripping the returns from the market as a whole, Woodford is a voice worth listening to.

Over the past five years, for instance, his Invesco Perpetual High Income fund has returned precisely double the return from the FTSE All-Share index. And an investor putting 10,000 pounds into his High Income fund back in 1988 would have seen it grow to 193,000 pounds today -- that's quite some return.

Interested in discovering what other shares this investing maestro owns? Motley Fool analysts have just updated one of our most popular free reports -- "8 Shares Held by Britain's Super‑Investor" -- in light of recent changes in Woodford's portfolio. To download the report, simply click here. It's free, so what have you got to lose?